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WHITE MOUNT INS GRP LTD BERM (NYSE:WTM)

Annual Investor Meeting

June 07, 2013 10:00 am ET

Executives

Raymond Barrette - Chairman, Chief Executive Officer, Member of OneBeacon Compensation Committee and Member of Finance Committee

T. Michael Miller - Chief Executive Officer of Onebeacon, President of Onebeacon and Chief Operating Officer of Onebeacon

Allan L. Waters - Chief Executive Officer and President

G. Manning Rountree - President of WM Advisors and Managing Director of White Mountains Capital Inc

David Linker

David T. Foy - Chief Financial Officer and Executive Vice President

John Davies Gillespie - Director, Member of Finance Committee, Director of OneBeacon Insurance Group LLC and Director of Folksamerica Holding Company Inc

Raymond Barrette

Okay. Well, it's 10:00, let's get started. Welcome to the White Mountains Annual Investor Meeting. It's good to see you, all, in this beautiful Friday morning. Before we go with our regular business, as you probably all know that Jack Byrne passed away in March. We think it's a good time to remember and celebrate Jack, so we have a few things for Jack. After Travelers and GEICO, where you had very successful -- a very successful career, he joined White Mountains Fireman's Fund Corp. in 1985, and led what it was a large IPO at that time, very successfully. He remained Chairman, CEO, Director until 2007 when he fully retired for the last time. In 2001, he was named Insurance Leader of the Year. In 2009, he was inducted in the International Insurance Hall of Fame. So clearly, he's had an impact on the world of insurance and the world generally and certainly in White Mountains.

The Board of White Mountains passed a resolution at its May board meeting. I will read it for you, "Whereas Mr. John J. "Jack" Byrne was the founder of the company, its Chairman and CEO from '85 to '03; a Director until '07; a friend, mentor and inspiration to the board, management and employees during those years and beyond; whereas Jack had an outstanding career with major achievements at Travelers, GEICO, Fireman's Fund, White Mountains, OneBeacon Insurance; and whereas Jack's track record of creating value for owners is among the best, having compounded book value per share by 15% since the IPO; and whereas, Jack's brilliance as an insurance executive was only exceeded by his brilliance as a leader, incisive, bold, passionate and able to connect with people regardless of rank or station; the best General Manager Warren Buffett ever saw; and whereas Jack led us, pushed us, and cajoled us all to inspire us to do our best and even more than we thought possible; and whereas Jack reminded us of the Russian proverb, 'Dwell on the past and you will lose an eye, forget the past and you'll lose both eyes.' It is, therefore, resolved that we will never forget and it is further resolved that the Board expresses its sincerest admiration and gratitude for all that Jack did for the company and its owners and employees, and offers its deepest condolences to Mrs. Byrne and the Byrne family." So we have this resolution put in a nice binder that we will offer to Mrs. Byrne and her family when we return to Hanover.

So to -- for those of you who don't know Jack or those of you who know Jack but want to remember some of good things we did, we were able to get the videos of 2 events that took place in 2000 and 2001. In 2000, Ron Ferguson was named Insurance Leader of the Year, and he asked Jack to introduce him at that event. There's always at least one introducer to the event. So we have taken this video, and it shows, first, Bob [ph] introducing Jack, and then Jack introducing Ron Ferguson. [indiscernible] This is the editing of the video, may be a little confusing when you'd see it, so I'm giving you this sequence so you realize what's really going on. Because Jack tended to confuse the situation. And then the next year, Jack was named Insurance Leader of the Year, and he was filmed giving his spontaneous reaction to getting the award which is in itself pretty interesting, then Ron Ferguson introduced Jack, and then Jack did an acceptance speech. So the video is about 15 minutes. I think you will enjoy it.

[Presentation]

Raymond Barrette

A tough act to follow, we try everyday, but here we are, we're going to return to our normal business here. It's been quite a ride, and hopefully, the next 20 years will be as interesting and fun as the last 20 years have been, 25 years.

So let me, first, introduce the Board Members who are in attendance this year: Mike Frinquelli is on the White Mountains Board; Howard Clark; John Gillespie; Morgan Davis; Steve [ph]. I think I have all of them, those present here. And the 5 of us -- 6 of us who will present this morning is David Linker who runs our fixed income portfolio; David Foy, I'm not going to forget the names, this time; David Foy, our CFO; Allan Waters runs Sirius, our reinsurance business; Mike Miller runs OneBeacon. He will make a short presentation this morning, but he has his own full investor meeting this afternoon at 1:00 in this hotel. Is it in this room? I think it's even in this room. And he serves lunch in between, so if you're interested in having lunch; and Manning Rountree is, basically does a lot of things at White Mountains, but among other things, he basically oversees the investment functions. He's not a Chief Investment Officer, but he makes sure that the investment of portfolio managers have freedom to work in a very good environment and keeps track of risk and keeps tracks of reporting and all that.

So first, we'll go through our -- no, oh, did I skip a page? First off, okay, I have introduced all that. Let's go to the next page. Don't we do the forward-looking statements? Don't we have to do that? Oh, it's done? Okay, sorry. Thank you.

Okay. 2012, it's getting a little bit old, but quickly, we had a pretty good year, 9% growth in adjusted book value per share. Another great year but in a 2% interest rate world, it's not a bad year. We -- it's above our 700 basis points over the 10-year treasury. So I think over the long term, if we could deliver that, you would be happy. We had good underwriting. OneBeacon had a 98% combined ratio, a little elevated mostly because of Sandy, but overall, the run rate is good and Sirius had a very good year of 90% combined ratio despite lots of storms and crop losses and all that. Our total return on investment was 5.6%, a very good number. If we could do that every year, we'd be in heaven. Our fixed income had a total return of 3.8%, beating the aggregate, the Barclays aggregate. Equity, total return of 10.2, which is good enough, trail the S&P a little bit, and we'll talk about -- we don't expect that the S&P is up 16% to match the S&P on average. But we'll talk about that. And currency exposure at about 0.5 point through that -- to that return last year.

The big events were OneBeacon agreed to sell the runoff business. That deal is in the process of regulatory approval, and we think we will close that this year. We invested $600 million in the muni bond insurance business, and you'll hear a lot about that. We've talked about that last year, but now we're in business and it's working and Sean McCarthy, who is the CEO of Build America Mutual is here to answer questions and talk about that. We returned $675 million to shareholders, mostly through share buybacks of small dividends, really doesn't add up to a lot of money. But we bought back almost $670 million of shares. And finally, we have a $13 per share gain at Sirius. We had a large business in Sirius with a large safety reserve. We accrue a deferred tax liability on that safety reserve for GAAP purposes. The tax rate in Sweden went down from 26-something to 20%, 21%, I forgot exactly. So we had a pretty good gain, a GAAP gain. It doesn't change the economic value of the company, but it was a GAAP gain due to the reduction in rates.

So far this year, we've had a good start. Our book value per share grew 3.3% in the first quarter to 606, which is pretty good progress. Very good underwriting, 88% at OneBeacon, 81% at Sirius. No caps helps a lot. It's easier to report good combined ratios and there's no caps and -- at least throughout the first quarter. There's some cuts going on now, but we don't think they'll be too serious for us, we can talk about that. So we'll return 1.5%, again, a good first quarter total return. Fixed income up 40 basis points versus Barclays was like 20 basis points. Equities, again, good absolute return, but trailing the S&P. And in this case the currency, the dollar went up and the currency is driving the result by about 40 basis points.

The growth in book value was held by 2 transaction gains, $15 million at OneBeacon with the termination of Hagerty last year and we sold Essentia to Markel. We had a $15 million after tax gain. We think that's a best termination we've ever had of any deal. And Sirius White Mountains Solutions had a gain of $7 million in closing one of the deals we negotiated last year. BAM insured $1.8 billion this year. I was told this morning we passed the $2 billion mark. So things are going very well, and we again will talk a lot about that. We captured about 1/2 of the deals in the insurance -- of the insured deals in the muni bond market, and we repurchased 140,000 shares for $79 million.

So our track record, this is kind of the Warren Buffett approach to comparing his growth and book value to the S&P 500. We do that, too, and you can see that in the last year with the S&P growing 14%. We didn't quite match that. But over 2, 3, 5, 7, 10-year period in the IPO, we've been able to create more value than investing in the S&P 500. And we work hard every day to try to maintain and improve that record. How do we do that? Just a couple of insights. OneBeacon, we invested in 2001 with a very -- which abet the company deal using book value as the current terminal value and we -- it produced an IRR of 14% after tax versus the S&P over that period would have been about 4%. So pretty good investment, and we think it's worth a lot more than book value. Sirius, we started investing in Folksamerica back in '96. Over those -- almost 20 years, we've had a return of about 10%, which is not tremendous, but not bad either versus an S&P of 7%. Symetra, we bought Symetra out of Safeco back in '04. So far, the return at our carrying value is about 11% -- 10.8%, versus an S&P of 6%. So those are the ways we've been able so far to create some value.

It's good to report the good things. We also have to report the less good things. We made the mistake of entering the Japanese variable annuity business back in '06. That turned out to be a disaster. We got in a business in a foreign country, a business we didn't know in a country we didn't know. Other than that, it was good. And we've lost almost $400 million. And we'll update you on that. We will try really hard not to make that mistake again.

So OneBeacon, Mike will talk about OneBeacon, but the first slide is the White Mountains view of OneBeacon. This is not that complicated, but basically, we invested $1.5 billion in OneBeacon back in '01. And the green line is total value creation by OneBeacon over that period of time. So it has consistently grown its value. But we have taken a lot of money out. OneBeacon has released a lot of capital to White Mountains. So our net cost for the -- our current holding that is worth almost $900 million in our cost to debt, $900 million is a negative $1.2 billion. So we basically have taken $1.2 billion of cash out of OneBeacon and the White Mountains ownership of OneBeacon is still worth almost $1 billion. So it's been -- this is how the 14% was created. And clearly, we think OneBeacon is getting better, not worse.

And to prove it to you, Mike will tell you about OneBeacon. Mike?

T. Michael Miller

Okay. Thank you, Ray. Good morning, everyone. This slide, some of you have seen over the past few years, it's a slide we put together at our 10-year anniversary, and it really -- there's a lot of information in here. And it was indicated we'll have a little more detail even this afternoon for those of you that can stay about what's going on at OneBeacon. But this really is the tale of the transformation and transition of the company from what was purchased in 2001, which was really a broad-based general insurance company here in the U.S., with roughly $3.3 billion of net premium at the time. And as many of you will recall, losing money at a pace of about $50 million a month. Jack and Ray moved to Boston, I think, to stem the $50 million a month loss as quickly as possible. And as you can see from the slide, that was transitioned and turned quickly and it's only a few years later, you see the company turn to an underwriting profit. Obviously, significant steps along the way, and I won't go into every one of them. But if we had a chart along the side, you would see there has been -- there had been transactions and activities and startups and exits of businesses every year along that 12-year track that you see.

And what we've really done is we've transitioned that company from a broad-based general insurance company that we've shrunk significantly to a specialty company. And while the company has shrunk overall, as you can see in the slide, you also see in the orange bars underneath that we have grown a $1 billion specialty company during that time. So as we were exiting the lesser performing businesses in general, commercial and personal lines, we have build up a specialty company that we think can outperform the general industry on an ongoing basis. Point in fact, if you look at the orange bars -- the orange line across the chart, you see that the results of our own specialty business that we have been developing and producing has in fact outperformed the overall performance, including the commercial lines and personal lines of the company. And that would also be the case if you looked externally at our peer group. So the bottom line is we really felt that we needed to transition the organization to a focused specialized company with niches where we have standalone businesses and business leaders that have great depth and expertise in those industries, understand how to drive profitable results, have a history of doing so, and we build up a team of roughly 12 of those operations and we continue to look at more almost every year.

Next slide, please. In 2012, as we take a quick look back, Ray alluded to, our runoff sale. It was announced last year and we're working through the process, as Ray indicated. We booked $100 million of GAAP loss which we really look at the economic loss that we would have incurred on that portfolio over time. And we've accelerated that to try to close it to allow us to focus the capital and the energies of this ongoing enterprise on businesses that are producing returns that we're excited about versus the drag from runoff. As well, we terminated our Hagerty relationship. We think, and overall, a very good relationship over a 5-year period of time. We're running off the business this year, and we were able to book a $15 million after-tax gain. And as we look at the history of that relationship for us, it was a very profitable venture.

We added new teams last year, new segments as well. We get into the program business. We hired a gentleman named Dan Beaudette, and a few people that are working with him. And we think over time, this will be a nice business for us. We also entered the commercial surety business, Chad Anderson is the leader of that business that we hired. And over time, Chad and his team will build what we think will be a specialty commercial surety business that fits nicely into our platform. We are not in the contractury business, so it's really focused on the credit, commercial insurance -- commercial surety business. And additionally, we added teams of people in the inland marine business, a business we have been in, but we identified opportunity we thought to grow that platform in a very profitable part of the insurance business, and we added teams of people around the country last year to help us do that.

As we roll forward to the first quarter of this year, as was indicated earlier, we're off to a good start. Book value growth up just under 7% and an 88 combined ratio for the first quarter which we're very pleased by, there were no significant catastrophe losses. As you know, as a roll forward to what's going on now with the recent events in Oklahoma, as well as Florida. We don't see those being a meaningful or significant events for OneBeacon. As you will recall in 2010, we exited the personal insurance business, which was concentrated in the Northeast, and we also sold our general commercial business. So we were not as affected by those events as we might have been otherwise years ago.

We had a relatively modest premium growth in the first quarter. I think right now, it's a very interesting insurance marketplace. One that I would refer to as a little bit schizophrenic, but maybe you'd call that the insurance market overall, overall history. It's a marketplace where renewal price increases are available on the business that you currently have, somewhere in the mid-single-digit range. Yet as you go out to compete on new business, it's highly competitive. Everybody seems quite anxious just like we are to keep their own business, but when there's new business in the market, there's a very aggressive appetite to get it. So I think it's a time where discipline is very important so that we don't create tomorrow's problems today because of lack of discipline and improper pricing.

And finally, we expect to close the runoff sale. So I think overall, OneBeacon continues to be in a good stead. I think we're clear on what we want to do. We're clear on the businesses we're in, the direction that we're going, and I think have in front of as the opportunity to produce very good results.

So with that, I will turn it over to my colleague, Allan Waters, who's the CEO of Sirius.

Allan L. Waters

Thank you, Mike, good morning. Okay, this is a graph similar to the one we started off with OneBeacon. You can see in 1996, the initial investments in Folksamerica and the reinsurance business, big bump in capital in 2001 when the hard market hit. Another big bump in capital invested in 2004 when White Mountains acquired Sirius. Since 2007, the top area, the gray area, which is really capital returns to White Mountains, has been growing rapidly. We've returned over $2 billion of capital back to White Mountains since that day. That's been accomplished through issuance of some debt and some preferred stock to replace common equity. In addition to a series of reorganizations where we've improved our capital and operating efficiencies, we released an additional capital against the business. The blue area is White Mountains' investment in the reinsurance business over time, and you see that it's come down. It's come down from about $2.1 billion to $1.8 billion since 2007. A bump up in 2012 because we had 300 -- roughly $350 million of comprehensive earnings last year.

2012 was a pretty good year, 90% combined ratio. We had a $98 million loss from Sandy. That reserve is holding up really well, and I actually expect a little good news coming out from that reserve as we go forward. We did have a $25 million underwriting loss from agriculture. We had a big drought in the U.S. and also a drought in China. The U.S. drought was probably in terms of dryness, probably about the worst in 50 years I would guess. So that did produce a loss for us last year, but it's a good business overall.

Gross written premiums grew 6% last year and have grown 18% over the last 3 years. Loss reserves developed favorably by another $34 million. White Mountains Solutions acquired 4 companies in 2 separate transactions, producing $14 million of after-tax gains, and we'll talk a little closer look at White Mountains Solutions in a minute. $115 million of capital, additional capital is returned to White Mountains, and regulatory capital grew 20% last year to $2.5 billion, again driven by the roughly $350 million of comprehensive income. $190 million of that was one-time tax benefits, including $65 million related to the reduction in the tax rate in Sweden. The other gain -- the other tax rate benefits were really because of restructuring and tax planning things that we did.

Now it's important to keep in mind, these are tax assets, deferred tax assets, deferred tax liabilities. We really don't pay hardly any cash taxes, in any jurisdiction anywhere around the globe, so we're not in cash pay. Well, anyway, 1Q '13, 81% combined ratio, no large losses, very low CAT activity. Gross written premiums did ease 3% during the quarter. That's mostly because we had a large account in A&H that usually renews in the first quarter, wind up renewing in the second quarter. And White Mountains Solutions closed another transaction for another $7 million gain and announced another one that we expect to close later in the year.

This is our calendar year combined ratio. The red line is the annual number from 2007 through the first quarter of 2013, and you can see it moves up and down a bit, based upon principally the incurrence of CATs from 1 year to another. Because of that, we'd like to focus a little bit more on the 3-year rolling result, which is the blue line. It's a better indicator of how the business is really doing over time. And you can see that, that line has come down nicely since 2007. And currently in the most recent period, we're roughly 90% 3-year rolling combined ratio. And that's about our run rate today. If you put in our CAT load, what we expect for average CATs over a long period of time against our premium base and add that to the rest of our operating results, we're roughly at around 89% or 90% combined ratio going forward.

This is looking at Sirius International, which is our Swedish company, again, acquired by White Mountains in 2004. And except in 2012, we now begun to include Sirius America results because Sirius America has become a wholly-owned subsidiary, of Sirius International. And it's comparing Sirius International's combined ratio against the reinsurance industries. The red line on top is the industry result from 1993 through 2012. The blue line on the bottom is Sirius International's result and you can see that the industry's never beaten Sirius in that entire period of time. That's a unique track record. No other reinsurance company can show you that. The dotted lines are the average combined ratio and red for the industry and then blue for Sirius since 2004, since the acquisition by White Mountains of Sirius, again a big spread. That's about a 10 point spread since that acquisition. Again, a unique track record.

How was that done? Well, what we have is we got a group of locally branched, highly specialized and qualified underwriters around the world who have relationships, long-term relationships with local and regional insurance counterparties. That generates a portfolio that has over 5,000 treaties in it, and over 3,800 direct and facultative binders and certificates. You're not going to see that from any of our peers in Bermuda, that type of portfolio. These long-term relationships also generate very sticky premiums, almost 2/3 of our premiums had -- relate to accounts that have been with us over 10 years, almost 1/3 over 20 years. Again, not something you're going to see from a typical peer operating out of Bermuda. They don't have that kind of portfolio. That's the Sirius difference. It's really the local relationships and the focus on local and regional counterparties that make this book different than most of the books you look at in the reinsurance business today.

White Mountains Solutions is a group of individuals who joined White Mountains in 2000. They actually came on us [ph] from Travelers. They've been together since the mid-'90s so it's almost probably 18 years now, they've been together as a team. Of course, we've added team members over time. They are experienced in claims, actuarial and finance and accounting. They have their own expertises right in-house to execute, and they focus on acquisition of runoff books of business. They have a rigorous, due diligence process, which makes sure that every asset and liability is conservatively stated on the balance sheet that they're acquiring. If they think there is any risk that reserves could develop unfavorably relative to what we're paying for them, they'll use some creative techniques in actually structuring the transaction, for instance, a contingent note that will be part of the proceeds to the seller that will be adjusted down, if reserves develop unfavorably. And they've used that tool several times. To date, they have completed 11 transactions to acquire 16 companies. They generated after-tax earnings in excess of $150 million. The IRR, the average IRR on that combination of transactions is over 40% after-tax. And perhaps most importantly, of all of the 16 companies they have acquired, they've never had a miss. Everyone of them has done well. There's not been any misses there. Strong pipeline, such would. Strong pipeline and new opportunities right now. The business is picking up. You can tell, we announced a couple of drafts as of last year. We've announced close another one this year, we've announced another one. There's a better pipeline here. This is their focus as on smaller to mid-size opportunities. A lot of the bigger transactions have been bid down in terms of returns, a lot of competition there, so we've changed our focus to focus more on small to mid and there's much less competition there and activity is picking up. So we're looking for good things from White Mountains Solutions for the next couple of years.

The capital markets are entering more and more into the property catastrophe business. They're taking up more and more of the capacity in that business. And that's really the best business in reinsurance, property CAT is a great business, it brings some very high returns, it's volatile, but the average return over a long period of time is very high. And so we're seeing...

Raymond Barrette

[indiscernible] you said property Casualty, you mean?

Allan L. Waters

Property CAT.

Raymond Barrette

Property CAT. Yes.

Allan L. Waters

I meant, Property CAT. Did I say Casualty?

Raymond Barrette

Yes.

Allan L. Waters

I don't use that word anymore.

Raymond Barrette

I know.

Allan L. Waters

So anyway, property CAT business, I'm sorry. So last year, I -- estimates are at the -- that the capital market has probably had about 15% of the property CAT capacity globally. The biggest impact is in the U.S., and these are trades in insurance linked securities, ILS is the term that you're going to hear if you studied the reinsurance business and how it's changing. Over time, we think that the ILS market may actually create a big change in the basic business model for certain lines of reinsurance business. We've got a transition frame perhaps from running risk and profit for our owners' capital to running risk and profit for third-party money, OPM, other people's money. The whole industry is going to perhaps go through that transition. That can be a pretty good business, I mean, a great business, managing other people's money for a fee doesn't require hardly any capital. It's not very risky and it can regenerate a nice return on capital. But that's a big transition for the industry to go through. And so getting from here to there is going to take some time, and there'll be winners and there'll be losers. We want to play in that game. I think the whole industry, our broker friends, the rest of our peers, they're all jumping in. They're basically trying to and we're going to keep in the action here, in a very good business by transitioning into perhaps what's a more efficient capital approach to running the business.

And so we've now announced our own Sirius Capital markets entity. We're going to have 2 companies under that: One of them will be located in New York, Sirius Capital Markets U.S. Michael Halsband, who we just -- we'll see him somewhere -- where Michael is, but we just hired Michael about 1.5 month ago. He's a formally of Goldman Sachs and Deutsche Bank. He's been in the ILS arena for quite some time. He's got over 23 years experience in the insurance and reinsurance business, and that entity is going to be responsible for marketing and asset collection, bringing assets in to become under management. In Bermuda, the operation's going to be headed up by Deanne Nixon. I haven't seen Deanne today, but I don't know if she's here. But she's been with us for 10 years, most recently in our Bermuda branch, and she has also over 20 years experience in the business. And she's going to be overseeing the entity that's going to do the risks selection side of this business, and will be running risk and selection and assets and profitability for third-party money for a fee. That's the idea here.

We'll be leveraging Sirius' long-term track record in entering this business. We have a secret sauce. That track record is very valuable. You see me in a room with a counterparty, and show them that graph I showed you a few minutes ago, that catches eyeballs. And they can participate a little bit and some of that track record along with some more generic market trades, we'll leverage that track record, that will help us launch this business. It's early days, we're just forming the companies. We're just getting out and having our first marketing events. But we expect this to complement our current business model. We expect to see more opportunities from brokers, as a result of entering this new side of the business. This will add value over time. It's not going to move the needle from the first couple of years here. We're got to collect an adequate amount of assets before it really starts to move the needle. But in the long run, we hope that this will be a big winner.

Looking forward, U.S. Property Cat rates are now easy. In fact, they eased pretty song strongly in May and June in the southeast, in Florida in particular, you see that. That's partly the capital markets in, providing more capacity. There's a lot of capacity in traditional reinsurance also. Primary property pricing in the U.S. continues to improve. So our pro rata accounts and our pre-risk accounts are participating in that, although the rate of improvement is now slowing down a bit.

More globally, the rest of the world, I would say, overall, property rates are roughly flat, certain territories are up, some are down a little bit. But I'd say roughly flat, maybe up slightly year-to-date. The ILS market will have a much slower impact on many of our territories. I mean, it has some impact in Europe, very little impact in Japan at this point and then on the less prominent zones, it's going to take a long time to have a major impact there.

Our Accident & Health results, they weren't good for a couple of years. 2011 and 2012 calendar year results weren't that good. And we have 4 bad accounts from underwriting year 2011. They had to be sold. One of them was repriced and eventually canceled and the other 3 were canceled immediately. Our results are back on track. A&H results are looking good this year. We expect to show some new growth later in the year from our U.S. primary business that we're starting up with 3 separate clients, and on the long run, we look for pretty good growth out of that engine.

Aviation remains highly competitive. Everyone's looking for the more top line. We're not focused on that. Our Zurich team is managing through that very well. They're cutting back their books slightly as they need to, and the results remain strong. We had this business in Copenhagen that we started about 4 years ago. It's a direct aviation business, fairly high cost to get into that business, and they had to grow so that their top line would cover their costs and then go from there. And they finally achieved that beginning this first quarter of this year, second quarter of this year. They'll show an underwriting profit. The loss ratio on that business has always been very good. So it's just a matter of getting up to scale to cover their operating costs and they should look better and better going forward.

Trade Credit is predominantly European Trade Credit, short duration. Of course we've got 0 Eurozone stresses there. Our clients are in managing through that very well, a lot of skill there, just like they did in 2008 and 2009. So that book still looks good to us. Plenty of capacity in the reinsurance business. And so we don't see a hard market anywhere in the near future unless there's some catalyst to cause that. So we're more focused on the bottom line. Well and out we grow much in premiums going forward, not so sure about that, but we'll continue to do the best return on capital given the dealt hand we're dealt in the business for you.

HG Re, HG Global and BAM, this is our first -- our third try, third run in this business. We were White Mountains and its predecessor, Fireman's Fund Corp. is a founding member of MBIA in the early '70s. And we continue to own that stock through its IPO and finally sold our last shares of MBIA in 1992. In 2004, we invested in FSA which is run by Bob Cochran and Séan McCarthy. You got to know them, helped that public offering. And owned those shares until 2000 when we sold our last shares of FSA. And both of those were highly profitable ventures for White Mountains. Third time's the charm, hopefully, even better, right, Séan? Bob and Séan came to us in the summer of 2011 with a new model for this business. A combination of a mutually-owned insurance company, BAM, and a privately-owned reinsurance company, HG Re. That combination has a lower cost to capital by far than any purely stocked company. So none of our competitors have this structure. It also creates a very sticky relationship between BAM and its customers, the municipal bond issuers. We capitalized it last year, got a AA rating from S&P, the only AA rating active in the business. New York state issued its first mutual license in 40 years. we're currently licensed in 44 states from the District of Columbia. There's only one big state left to be licensed, that's Florida and we expect that in the next few weeks.

Underwriting comes first, just like all the businesses we're associated with. We start with a strong, strong and experienced management teams, both at BAM and at HG Re. There's a lot of depth from the management team and we've known a lot of these people for a long time from FSA days. BAM insures only essential purpose -- essential public purpose municipal debt. These are geo bonds, revenue bonds, all high-quality. 100% investment-grade. In fact as of today, I'd say over 80% of BAM's portfolio that's insured represents geo bonds with a rating of A or higher before being insured. But very high quality insurance portfolio, no legacy issues, no asset backed securities in BAM's portfolio. Not today, never in the future. It's not in our charter. We can't do it. That's unique. All of our competitors, our potential competitors have that issue, legacy issues. We don't. Each issue is individually underwritten, one by one by one. Entire committee looks at it, studies it. We don't all have to approve it. A big hot button in this area is pension and other employee benefit retirement benefits, OPEBs and the liabilities that issuers, that municipalities and states are holding on their balance sheets, not being properly stated. We have our own internal actuary, he's a solid guy. He's got the right attitude, he studies every single liability on these balance sheets, whether there's closed, whether they're on the balance sheet or not on the balance sheet, whether it's disposed or not disposed, he goes to every single liability. He didn't -- and makes sure that he's comfortable with what they're stated at and that they're properly reflected in the balance sheet. And if not, he creates his own number and we put that on the balance sheet. And so when we underwrite an issue, we're underwriting it based upon our assessment of their funding requirements and their ultimate liability for pensions and OPEBs. We're making sure that we get that number right upfront, and we don't take in a step into any problem areas that they're going to hit us later down the road. Zero loss underwriting standard, every time we write a bond, we're expecting 0 loss on that bond. And we write to AAA guidelines. That means we can withstand an S&P AAA scenario depression and still keep our rating, have enough capital for our rating.

Our target market is the regional broker-dealer and retail investors. This is where we can deliver value. They still need this product, they still want this product, there's a high demand for it. Our target average size is $25 million par value insured. Now BAM's publishing surveillance, available to anybody, for each security that it underwrites. That brings value to the broker and the dealer because otherwise they'd have to do that surveillance themselves. And the requirements for them to keep a surveillance file on all the issues that they underwrite has just exploded in the last 10 years. And so for small broker-dealers to do that themselves, they can handle the cost. So BAM brings value to them by publishing that, and they can rely on BAM's files for that purpose. BAM collects both risk premiums and member surplus contributions from each issuer as they use BAM's products. Member surplus contributions, MSC. MSCs are reusable, that refunding of the issue. Most municipal bonds refund before their final maturity. The fact that the MSC can be reused by the issuer makes that relationship sticky, much more likely to reuse BAM's product time and time and time again. And in the long run, BAM expects to pay dividends to its municipal owners. As municipalities use BAM's products and pay the MSC, the member surplus contribution and they become owners of BAM and eventually they're going to start to get a dividend stream out of that ownership. Additional stickiness in that relationship. So over time, this will just build more and more momentum. Again, this is a unique, unique way of targeting this business. Nobody else has this. This should work very well as we go through time.

And here's the real key, the capital advantage. You see in the blue, private capital, White Mountains, seeded to start up at this enterprise. As municipal issuers use BAM's products, they are paying member surplus contributions, they become owners of BAM. And over time, those MSCs represent an increasingly greater proportion of the capital that runs this combined engine of BAM and HG Re. The cost of capital on the mutually owned BAM is very, very low. And so on a blended basis, over a long period of time, 6% or 7% total return generates a very nice return for the private investor here. Again, something that none of our competitors have. And gives us a long-term permanent capital advantage. I guess somebody could replicate this, but they'd have to have put a pretty good story to come in, especially if they have legacy issues that they're trying to replicate something like this mutualized.

One other key to this relationship is the long-term reinsurance treaty. It's a 15% first loss treaty. What that means is that HG Re will pay a loss on any issue up to 15% of par value. At that point, HG Re is stopped from paying any more on that particular issue. So it's security by security by security, 15% first loss. What that does is marginize the risk for owners of BAM. They don't have to worry. Municipality A, they don't have to worry about municipality B if they might actually miss a payment, interest payment or 2 and impair their BAM stock value. They don't have to worry about that. We take that off the table. That's what we get paid for. And we get paid 60% of the risk premium collected by BAM, net of commissions for that. On the treaty, the economics may reset at the end of 10 years and every 5 years thereafter. Not necessarily will reset, but they may reset. The treaty is collateralized by 2 trusts. In total, the target balance for those trusts is unearned premium reserve, plus any loss reserves that might have been booked at any time plus $400 million. That's defined in the treaty. And what's really important is that the aggregate loss limit under the treaty is equal to the trust balances. So if the world went to hell in a hand basket, there's no capital call to HG Re to HG Holdings or to White Mountains beyond the balance and the trusts.

BAM's making great, great progress, establishing its market presence and its trading value. There are a couple of headwinds when we entered the business that got a little worse between the time we funded the business and the time we launched really in January is when we launched. Interest rates have come down further and credit spreads have tightened further. Those are headwinds for BAM's business. Despite those headwinds, they're writing about 50% of the market today. They're over $2 billion, and you can see at an accelerating pace. The business is growing from month-to-month. So, so far so good. We're looking good, we think we're really happy with the way things are going on. The management team is strong at BAM. They're working hard, I can tell you to a person the whole team is working hard to make this work and they're doing a great job.

Okay. With that, I'd like to turn it over to Manny and to David who will take you through our investment approach and our returns. Thank you.

G. Manning Rountree

Thank you, Allan. White Mountains' approach to investment is the same for many years. Our objective is to invest for total returns. And we do that in practice by managing 2 distinct portfolios of assets. Our policyholder funds, which we back with a high-quality fixed income instrument, and our shareholders' funds where we take a more aggressive posture typically with a high equity component subject to what we feel comfortable in the context of our overall risk profile in the balance sheet.

Our equity exposure at the end of the first quarter is 47%. If you add some unfunded commitments worth 50%. That's a comfortable level for us, and we're relatively standing path. Our equities are generally value-oriented, and it's a mix of subsectors, not just common stocks, but also convertibles, high-yield bonds, alternative investment. That mix and orientation inside the equity portfolio is one of the reasons that in a strong upmarket will tend to lag, with the goal of outperforming when market corrections come.

We have some non-U.S. exposures that are meaningful at Sirius Group, which is a Swedish company. We manage those very carefully. The first thing we do is we match our assets and liabilities inside Sirius' balance sheet by currency. And then we balanced the capital base of Sirius fairly neutrally. We do that because we lack a conviction about the direction of the relative interest rates that are involved. So we typically hedge our bets. Right now, we have a slight lean towards the dollar and more recently toward the kroner and away from the euro.

These are our returns for the first quarter and then 1, 5 and 12 year ended 12/31. If you look in the second column, you'll see the 1-year result. Total portfolio return, 5.6%, which is a solid return. If you disaggregate it, the fixed income portfolio was 3.8. It outperformed the Barclays aggregate by 20 basis points despite the shorter duration portfolio. We really achieved that through some fairly aggressive sector rotation and rate rotation during the year, which David will talk to. Equities underperformed the S&P but produced a nice absolute return of 10% and currencies held 50 basis points of tailwind in the calendar year. The first quarter is really a continuation of the same story. Fixed income has outperformed and has continued to outperform in this most recent period of rising rates. The equity performance has lagged the S&P but been good in absolute terms, but the dollar has reversed in the first quarter. Still a good result at 1.5% for the quarter.

And here is really the story of our equity exposure over time. You see in the far left-hand corner, this was in mid-year 2008 precrisis. The black line shows you our total equity exposure as a percentage of shareholders' equity, we were at 72%. And in retrospect, that was too high. And in order to preserve capital as market's corrected, we had to sell equities on the way down, and at the bottom in '08 and '09 since we did not want to do but had to for capital preservation reasons. And since then, you can see we gradually rebuilt the exposure and it's leveled of in the high 40s. So up from the bottom, but well off our peak exposure back in '08 and we're at a level where we feel very comfortable.

The shaded bars show you the mix of inside the equity portfolio. And you can see the orange segment is common stocks. In '08, we sold what was liquid, which was the common stock portfolio. And by '09, we had a portfolio that was very light on common stocks, very heavy to alternative. And over the past 4 years, it's been sort of a gradual process of trying to work the portfolio back to a balance that we feel more comfortable with, and I think we're there. I think in terms of aggregate, equity exposure and mix, we're in a good spot.

So with that, I'm going to let David talk about what's going on in fixed income.

David Linker

Thank you, Manning, and good morning. Slide is entitled Fixed Income Investing For Total Returns, which is a little difficult in this market, so why don't we talk a little bit about that.

When we take a look, we see an asymmetric market landscape, and it's not in a good way. As everybody's aware, rates are very low right now. You may have seen Bill Gross tweeting a few weeks ago that the 30-year bull bond market is over, and that we're looking at higher rates going forward. I don't know if it's over yet, but we can certainly see it from where we are right now. On the other side of that, we really have a natural boundary of 0%, rates are extraordinarily low right now, and there's really a limit to where they can go in terms of appreciation for the bond portfolio. And as you've seen from the last few weeks, we've had a backup in interest rates, and we've also had an increase in volatility in the fixed income market. And we think that, that is just a taste of what you're going to see when central banks taper what they're doing or stop what they're doing or someday maybe reverse what they've done. So it's a tough market in that respect. And it's also asymmetric with respect to spreads. Because of all the money printing that's gone on all over the world, there has been a tremendous spread tightening across all fixed income, high-quality assets are extremely expensive right now. But it's not just quality assets, jump ons have reached all-time highs in the marketplace.

So when we're looking at the landscape, it's a pretty tough environment for fixed income. But the good news is that we think we have been positioned for this, and it's been working over the last year or so, and we think we are positioned in a good way for it now. First of all, we have a short duration, I think what you saw from the other slide, I think our duration was 2.6 at the end of the first quarter, I believe. It's in that ballpark at this point in time. So if interest rates back up, we're not going to see a big mark-to-market loss, one of the opportunities to put money out of higher rates.

In addition, we're hurdling higher cash balances in the portfolio. This is not just cash, it's cash and treasury bills and high-quality short-term asset-backed securities. It doesn't really cost very much to do it, given how low interest rates are. And it takes a lot of the price risk out of the portfolio. And we think that's important. We think they are going to be better entry points to come in and put that money out on the yield curve. And the third way we're doing it is with a focus on corporate debt. And we're doing this for 2 reasons. First of all, from a credit perspective, we think corporation's balance sheets are in terrific shape right now. They've really taken advantage of the low interest rate environment to issue longer-term debt at low rates, and we think that they really can hold the spreads that they have, much better than other areas of fixed income if the fundamentals are just so strong. In addition, corporate debt is generally issued in bullet bond structures, and so it doesn't carry the extension risk of some other type of instruments. When interest rates go up like mortgage-backed securities for instance, a lot of fixed income managers are trying to get excess return by investing a lot of their portfolio in mortgages. They're, in effect, shorting options. If interest rates go up, they can extend dramatically, and that will have a detrimental impact on total return.

So what are we going to do this year? How are we going to make money? It's actually a pretty good question. We ask ourselves that a lot given what we're looking at. We're going to continue doing what we're doing which is sector rotation. So when a sector becomes really dear, we will look to sell our positions and rotate into a sector where we think there's at least some possibility of spread compression so we can make money. That's getting more difficult than it has been, but we'll continue to do that. And we'll take advantage of volatility. This is actually a bright spot in the market. For the last year or so, the bond market volatility has been very low. All of this money printing has really just sucked the volatility out of the marketplace. But in the last few weeks, we've seen a lot of volatility in the bond market. And when that happens, you have price dislocations, you have price discovery, and you have the opportunity to buy bonds at wider spreads than you would otherwise be able to do. We can provide liquidity to the market when this sort of things happen and take advantage of it.

So nothing particularly exciting. It's going to be difficult to make money and bonds in this market. But we are going to do it tactically, and we're going to do it one small trade at a time and we're going to put a nice year together. And that's the plan. So far, so good. Given the way we've been positioned even with this backup in the market that we've seen, we are profitable. And just imagine for a total return, it's not enough to lose less than the market. We're going to try everything we can to make a nice profit regardless of whether or not we back up or not.

And with that, I'll turn it over to our CFO, David Foy.

David T. Foy

Okay. So I'm going to start off on Life Re, which has been in runoffs since the financial crisis. It has been running at about a $5 million loss per quarter for the last couple of years, and has 3 more years to run. There has been a couple of developments this year that I wanted to make you aware of. Number one, with the market moving up and with the yen coming down, the account value has caught up to the guarantee value. And so the contracts are no longer way in the money. It's now about at the money. And so what that does is a couple of things. One, it does modestly increase our hedging costs a bit. So on the margin, that $5 million a quarter, you could see it go up $1 million or $2 million a quarter. However, there could be a potential offset because surrenders are now increasing pretty dramatically. And that is probably the result of now these contracts are no longer in the money for the customer, and so -- and there's no surrender charge so they can move the contract without losing everything. So the surrender -- surrenders have gone up, and so we may see a benefit offsetting if we change our surrender assumptions. That would be more lumpy, so with any quarter we change it, that would be when the benefit comes through.

Going to the next slide, just talk about Symetra for a minute. Symetra's been a good investment for us. We invested $195 million in 2004, including dividends that's grown to over $400 million and an IRR of around 11%. That's at our carrying value which is at a slight discount to Symetra's book value. The market values actually had a bit more of a discount to their book value. And so if you look at it at a market value basis, it's more like a 9% return over that period. That compares favorably to the S&P 500 of 6%, and certainly much better than the financials has done over that period.

Going to talk a little bit of the history of White Mountains' share count, just to give you some context before I talk a little bit about recent activity in share repurchase. Going back to the Fireman's Fund IPO with Jack that was talked about earlier, there were 66 million shares through the sale of Fireman's Fund Insurance Company to Allianz and then shortly thereafter, the share count reduced dramatically from 66 million shares down to 14 million shares, so almost 80% of the outstanding shares were repurchased.

Then in the period of the '90s, when the stock was mostly trading at a discount to book, we were opportunistic. We bought about 8 million of those shares back, another full 60% of the shares outstanding at the start of that period. So that worked out very well for us and that helped us accrete our book value.

Then you go to the OneBeacon acquisition. We issued shares, and then for much of that period, before the crisis, we were trading at a premium to book. And so there wasn't really that opportunity to buy back shares. And so our share count went up from about 6 million to 11 million shares over that period. And now you get into the postcrisis period, where for the most part, our stock has traded at a discount to book. We've once again been opportunistic and we brought the share count almost back to where it was before the OneBeacon acquisition at around 6 million shares.

Drilling down into the last 13 quarters, we bought back about a billion and a quarter of our stock, 2.8 million shares at an average price of $4.38 and our current book value is $6.06, and so that's a 6.72% of today's book value. So that's been a great opportunity for us but of course the stock price has started to catch up to our book value so it may not be as big of an opportunity going forward.

Quickly on our balance sheet. There it is. Back in 2011, after the Esurance sale, we had over $2 billion of undeployed capital relative to a $5.3 billion of total capital and about $4 billion of shareholders' equity. We did deploy about $1.3 billion last year in funding BAM and repurchasing our shares. That still leaves us with over $1 billion of undeployed capital out of a little under $4 billion. And that debt to total cap is in the low teens, and so together with the undeployed capital and the financial flexibility that we could issue some debt if we needed to, we have quite a bit of financial flexibility and could execute a large transaction if a very attractive one came about.

Now to talk a little bit more about capital deployment opportunities, I'll turn it back over to Ray.

Raymond Barrette

Thank you, David. Okay, we're almost done here, we're getting to the Q&A. But basically, our job right now is to actively but patiently deploy our capital. We have over $1 billion of undeployed capital. We expect our operations to deliver more profit, more capital over time, and OneBeacon basically will have strong results. We expect to have strong results. They dissolved the runoff that will free some capital essentially the runoff of Hagerty, will free some capital. So we expect OneBeacon to create more undeployed capital over the next couple of years. It will grow. We expect OneBeacon to grow reasonably solidly. So it will reinvest some of that money, but not enough to use all the capital that it will create.

Sirius, we expect strong results at Sirius but that's much more dependent on weather and other events. So it's harder to predict quite what the excess capital will be. The casualty book is in runoff, it's been in runoff since the end of the hard market around '07, and we write basically no casualty anymore. And so there's a book in runoff that will free up some capital over time. And we see limited growth opportunities at Sirius. So as Allan mentioned, all the capital coming in, the places in A&H we expect to be able to grow, but these places will have to shrink. So net-net we don't see a lot of redeployment opportunity in Sirius.

Share repurchases may no longer be the obvious opportunity for us. A couple reasons, the share price clearly has moved up. It's very close to our adjusted book value per share. But underneath the adjusted book value per share, in the last few years, the book value per share has caught up quite a bit with the intrinsic business value of the company. If you remember prior to '11, we owned Esurance, we valued Esurance highly, we've had a large intrinsic business value for Esurance that was not booked on the balance sheet. We monetized that value back in '11 by selling to us, so that closed quite a bit of the gap between book value and intrinsic business value. And at Sirius, we have a large deferred tax and liability on a safety reserve that was kind of gap hidden -- not hidden, but it's a liability we never expect to pay, but that was on the GAAP basis, the book value was understating the intrinsic business value. In the last couple of years, with reorganizations and the advantage that we've been able to basically create tax assets that offset the tax liability. And net-net, the book value of Sirius is much closer to its intrinsic business value than it was before. And third, we have $1 billion of undeployed capital. What is the intrinsic business value of $1 billion of undeployed capital? We think we'll do great things with it, but it's a pretty tough world out there to invest at a great return. And so what we will do is we will carefully grow our businesses where we can. We think we have great teams out there. We constantly look for opportunities to create or buy or bring new teams on board. So we will carefully do that. There's no pressure to grow, but we like to grow if we can. And we will work hard to maximize the investment results. We've had a good long track record -- long-term track record. Our short-term record has been a little bit disappointing, but we think we're getting back on track, and we expect our investment results to deliver a lot of value for us -- for you.

We say this all the time, we are actively looking at a lot of deals in all the businesses all over the world, somebody asked me this morning, he said, you've been saying this for 3 years and you're not showing too many deals. It's an extremely competitive deal environment. We did deploy $1.3 billion of capital last year. So that's not like we've been totally idle. We deployed $600 million in BAM, with HG Global, and we repurchased almost $700 million worth of shares. So we were pretty active, and we are looking all the time. For example, Symetra, there were a lot of live deals available in the market in the last year or so, Aviva, and I forget the name, but a lot of them. We may have confidentiality agreements, I got to be careful. We competed on a lot of deals, and we thought we were aggressively pricing the deals and we lost every one of them, sometimes by a big margin. So it's a very, very competitive world out there.

So we keep looking, we look hard, we work hard, we even -- Manning and Morgan went to Brazil. We're building or helping build a little business in Brazil. So we do a lot of things, some of them are small, hopefully 10 years from now, you look back and say, wow, that was a great deal. So we were active, but we are patient. We have -- we will not do bad deals just so that we can report to you that we've done a deal. And I hope you appreciate that.

So what can you expect from us? More of the same. We're focused on growing book value per share, and we remain totally focused on that. It's harder to grow today than it was 5 years ago, but we expect the world to offer opportunities. It may not be tomorrow, but over time, we will see opportunities. We remain committed to our core operating principles. I won't repeat them. You probably can repeat them by heart. Capital management is clearly our biggest opportunity. We have a lot of capital, and we need to carefully deploy it or return it to you. And we constantly look at the pros and cons of that, and we will remain opportunistic. We have no imperative to do some things just because other people do it. Today, the returns in the marketplace in many deals are probably on the high-single digits, and we don't think this is a good way of deploying capital in high-single digits. We better wait for a world more in turmoil as it creates much better opportunities.

So when we see a good deal, we'll hit the bid quickly, and we have the capital to do it. But if we don't see good deals, we will be patient.

With that, that's the end of our -- a little bit longer than usual presentation. And we'd like to open for Q&A.

Question-and-Answer Session

Raymond Barrette

Yes, go on? Yes?

Unknown Attendee

I have 3 for David. Number one, the $1 billion in undeployed capital, is that after the cushion for ratings? You talked about a cushion in the management report.

David T. Foy

No, that would include the cushion.

Unknown Attendee

Okay, so it's $1 billion to do something with?

Raymond Barrette

Yes.

David T. Foy

No, I mean, no, the cushion is in there.

Unknown Attendee

So you wouldn't use the whole billion.

Raymond Barrette

Well, given a great opportunity and you will see the cushion shrink.

Unknown Attendee

Okay. I was going to ask about Life Re, so thank you for that slide. Does the fact that the account value's up and the surrenders are going up, does that enhance your ability to have a transaction and kind of put this behind you, or...

David T. Foy

I would -- I think from your seat as an owner, you should expect us to have it for the next 3 years, in June of 2016, we wrap it up and move on. There's always a chance of a transaction, but I always put the probability of that pretty well.

Raymond Barrette

I have developed one rule about Life Re.

Unknown Attendee

Don't talk about it?

Raymond Barrette

There's never any good news.

Unknown Attendee

Okay, so then, June of '16, what happens? Is there a cash transfer and you're done with that?

David T. Foy

Yes, we saddle up with the counterparty and then it's over. It's a bullet transaction. It's not something that can drag on for 20 years. June of 2016, it's over.

Unknown Attendee

So this would be a good meeting in 3 years. My third question is, David or for anyone, what's the natural return on equity today at White Mountains, operating return on equity today your mind?

David T. Foy

Yes, I would say that 8% or 9% that we've been running at is the natural return today. Obviously, historically, we've earned 15, but when interest rates are 10 years, 2%, 15 is unlikely to happen.

Raymond Barrette

I'd answer that a little differently. On the capital we've deployed at OneBeacon post selling of the runoff, I have really high expectations of our return on capital. I would be disappointed if it was not 12%, 13%, maybe more. So it's a great business and Mike has promised to deliver those numbers. The reinsurance business is a little tougher. It's under some pressure but still the profit [indiscernible] business, I would say at Sirius, we could expect we'd be 10-ish return, okay. Then we have BAM, BAM will build over time, but over time I expect the returns at BAM to be in the teens but then we have $1 billion on undeployed capital and what can you return on $1 billion? I sure hope it will be 20% but it's hard to see from here.

Unknown Shareholder

For Mr. Waters, you mentioned the advantage of the blend HG and BAM and the mutuals, I was wondering what's the barrier to entry would be from many competitors in that field because it sounds like a very inviting strategy. I did hear you mention something about legacy issues, but is there any real barrier to entry apart from that?

Allan L. Waters

Well, this is a business that's going to grow in value over time. You've got to be willing, as we were, to stake the capital upfront for a long-term business plan. So if you go to a private equity firm and they look at the duration, the tenure of this investment, most of them are going to take a pass on that because they're not -- they want to [indiscernible] strategy in 5 years. They want to understand how they cash out in 5 years. And they're not going to see that opportunity here. You got to be willing to buy and hold for a long period of time. It's sort of like an annuity business. You build it over time layer upon layer upon layer, and then the later layers are going to fit from the earlier layers and 5, 7 years out, you got great a business that's returning very handsome returns to the private capital. So it takes a lot of patience to enter this business.

Unknown Shareholder

More rapid return...

Allan L. Waters

Right. A lot of people who want their cash return earlier just not going to look at it.

Raymond Barrette

We tried to have probably the other capital come into the HG Global and failed miserably. Everybody wanted the clear exit strategy. And they like the model, they like the return, but they said where's [indiscernible] and when there was no clear exit, they didn't come in and then we try really hard. So private equity, it doesn't fit private equity and corporate capital is already trapped in a corporate structure, that doesn't mean somebody won't try to duplicate it. By the way, we have a patent pending on this structure, so we hope to slow down the competition. But it's not impossible that competition will come in, but intelligent competition is fine. The biggest problem in the business is people don't buy a lot of insurance. And the more people will think insurance, the better off we will be. You don't need 100% of the market. We just need a healthy insurance market.

Unknown Shareholder

This year, you didn't say that you will let the money burn a hole in your pocket.

Raymond Barrette

Well, I meant it.

Unknown Shareholder

I'm wondering if we -- given that your -- you don't seem to be very excited about fixed income, you don't seem to be very excited about your own stock price. You say the deal competition is ridiculously competitive. And clearly, you have deployed a lot of capital, so it's not like you've been sitting [indiscernible]. But is there some other options like either a special dividend that might be considered or is bullet burning a hole in your pocket a more viable scenario we should accept over the intermediate term?

Raymond Barrette

Well, clearly, if the stock price exceeds or comes [indiscernible] to exceed the intrinsic business value of the company, a dividend becomes a much more logical way of returning capital to shareholders. So if that happens, clearly, they will become much more of the potential offer. But we think in this world -- we look at the world, the Bernanke created world, and we think that it will not end well. And we think there's a real value, a real premium to being cash rich rather than cash poor. 15 years ago, we could go to the marketplace, do a OneBeacon deal and raise money pretty quickly to fund it. We did that with Symetra. We've been very successful at that. But we have not done that in a while, and we don't know in the current world, where private equities have done insurance deals on their own, some of them well, some of them not so well. It's less clear whether or not [indiscernible] showing up for a deal that we would quickly be able to raise the capital because they need our expertise. Expertise doesn't matter a lot when people want a 3% return or a 7% return. So we think being cash rich, being able to bring capital to the table at the right time in a crisis environment would be very value creating. So we are willing to hold on to the undeployed capital a little bit more patiently than maybe we would have been 10 years ago. But if this continues for another 10 years and we see no future, we will return the capital. Just to remind you, in the '90s, after the sale of [indiscernible] Fund, Jack and the team looked at every big property casualty company in the country, [indiscernible], [indiscernible] and [indiscernible] and all of these companies, we did due diligence on all of them. We bid on all of them. We won a couple of those deals just to be outbid later by somebody else who wanted the business more than us. So for 10 years, we were very patient. We did efforts, we other things in the meantime, but it's not until '91 and 2000, we worked all the time and never won a deal, and then we did OneBeacon and it transformed the company. And it's kind of what White Mountains is about. It's the ability to work hard, be patient, wait for the right deal, and when you get it, you get it and you do it. And that's kind of the environment we see ourselves.

Unknown Shareholder

If I could follow up, the stingy old goat has entered the excess surplus business in a quite dramatic way, and they also, at the same time, has come and bought a lot of naïve capacities that's come into the reinsurance business. So we have, I guess, both sides of the trade but, as far as capacity coming in, any comments on what the implications are to...

Raymond Barrette

Well, to us, this is a demonstration of why it's a tough environment even historically disciplined capital is now reaching out for market share, and that's bad news. I think as [indiscernible] said, he wants to build a $5 billion business in the U.S. That's after our insurer build a $2 billion business off the Lexington platform. So everybody wants to be big in that business, and that's bad news for margins. I'm not saying that [indiscernible] won't be successful but it will certainly squeeze the margins. And we're going to maneuver around that. So between pension plans, between the $100 billion of Berkshire and most companies being pretty with pretty healthy balance sheet, it's harder to know where the reserves stand today than they were 5 years ago. But overall balance sheet are pretty healthy. People want to grow. People want to be bigger. We expect a pretty tough market. Any good news? Any other -- yes here. That's the downside of this wide...

Unknown Shareholder

I went to the Travelers insurance meeting last month and they're very concerned about climate change and how it will affect their earnings particularly after what happened in Oklahoma. Could you comment on that?

Raymond Barrette

I'm a skeptic. I think there's a lot of climate variation in all that but I think climate change is an excuse. There's a lot going on. You can underwrite. You can diversify your book. I think we have way bigger problems than climate change in terms of managing our world and our economy and our business. Some of our partners might disagree.

Unknown Executive

All right, listen. Trying to fit any specific events on climate's change is a fool's game. Most scientists study this. They concluded that the number of storms forming really would not be affected by rise in ocean temperatures. The severity of storms would be impacted over time by a rise in ocean temperatures. So storms that might not otherwise strengthen as much will become stronger. I got to tell you, I think the industry is pricing much better against North Atlantic wind risk and much more disciplined. The models are much better than they were certainly 10, 12 years ago, there's no doubt about that. The model has become much more conservative. Rating agencies are requiring much more capital against that risk, so it's actually pushed down returns in the business. But the models are pretty well developed now, and I don't think that risks is underpriced today, and particularly if you're using a near-term model, which does reflect the more recent activity patterns. So it's a challenge, I suppose, for the industry. But so far, we've responded with more rates and it's working fine.

Raymond Barrette

Well, there are companies that had a lot of tornado at Midwest. Part of their issue is they used to avoid the code for earthquakes and wind and all jumped into the Midwest, and the Midwest was the most competitive, the most aggressively priced market in the last few years so the [indiscernible] the Midwest are a lot less attractive. So if you're a Travelers or Liberty Mutual or [indiscernible] Mutual, you have a problem. What you thought was your safe market is no longer a safe market. And is that climate change? I think the climate models are no better than our CAT model, which is not very good.

Unknown Shareholder

Regarding the insurance linked securities, are the outside investors, are they tying compensation to the reinsurers based on the performance of those securities at all, and if not, do you see that changing over time?

David T. Foy

There are structures out there that are not dissimilar to what you might see for an asset manager who's investing in the equity market, for instance, things of that nature. So there are performance-based incentives in place in a lot of structures, so the answer is yes, not in the securities themselves, but when you're hiring a manager, yes, there'll a performance component there, whether it's a profit share or whatever.

Raymond Barrette

We have not done a deal yet, so we don't know what may or may not be with the deals we do. But we expect the managers to be very focused on whether or not we are on the same boat as they are.

Unknown Shareholder

So is it fair to say then that, over time, expertise will become more valuable perhaps as the outside capital starts to hold their reinsurers more accountable for the performance?

Unknown Executive

We certainly, given our track record and the expertise we have in underwriter, that's part of our program, that, over time, differentiation will become possible as track records are published, and we hope to distinguish ourselves the way we have at Sirius International for a long period of time with a superior track record.

Raymond Barrette

Well the question [indiscernible] will the capital markets discipline the reinsurance world? My guess is not at the beginning. When everybody is chasing the volume, it's not likely to introduce this.

G. Manning Rountree

Right. It's more capital against the available risk, so I don't see it as disciplining event.

Raymond Barrette

It's not good news, but the question is can you make pay out of what is not good news?

G. Manning Rountree

Yes.

Unknown Shareholder

So right now, do you see outside capital not tying performance adequately to the compensation?

Raymond Barrette

Well it's just that performance standard is so much lower than ours. They're chasing 7% returns when we're chasing 10%, 12% returns. And so they're coming in to the market will make our job to get our returns much more difficult. At 8%, they'd be delighted than we'd be unhappy. So it's just that we have very different economics going into the business.

Unknown Executive

If you look at our pension fund, they cannot make their return objectives in lower interest rate environment. So they're looking for alternative asset classes, alternative risk sources, and they've discovered property CAT as a new class. They're getting to know it. They're investing in it. They haven't suffered any big losses yet, but because they're just trying to meet a fairly low return threshold, they're not as disciplined as reinsurance companies have been historically on the pricing they're requiring. So an ILS transaction today in the U.S. would go for a cheaper price than traditional reinsurance, which is why it's gaining market share.

Raymond Barrette

Just to give you a sense of price here, and correct my number if I remember it wrong, but I believe the pension funds are like $7 trillion of assets under management, roughly, I think -- and if we invest 2% of those assets in the property ILS world, it's $14 billion -- $140 billion. That would increase the reinsurance capital by at least 25%, 30%. And so that capital wants a smaller return than we historically have targeted. And that's 2%. If they deploy 3%, it's $200 million. So this is potentially a tsunami through the property tax business. We think we're as well positioned as most to defend our position. Sirius is -- if you're a Bermuda company writing large property CAT treaties in Florida, you're much more at risk than if you're Sirius writing little treaties in Germany, in Czechoslovakia and China and Thailand. So we have a book of business that will not be as quickly kind of impacted, although we do have a Bermuda book that would be impacted but it's relatively small compared to the whole book. So we're telling you that not because we're panicking. It's just something's happening, something is big. It's changing the economics of the business and we're trying to react. We think the property CAT business is still the best business out there, so it's not like it disappeared. But if this tsunami of capital comes in, it will change the business model a lot.

Unknown Shareholder

So just following up on that, do you think though that this inflow of capital that's chasing 8% dissipates when we get back to a more normal interest rate environment? So a lot of this, everyone chasing yields, is because we're at 2% 10 year, but when we get back to a 4%, 5%, does this capital not then disappear from the reinsurance market?

David T. Foy

Our impression is we get the question in twofold, will big event scare the capital out or will it change in interest rates? My impression, and everybody is going to have their own opinion, is a large event will likely cause a pause in the growth in the capital markets entering but not a permanent swaying off course. I think it will slow it down but then it will come back in. Higher interest rates could perhaps slow down the entry of capital markets into property CAT reinsurance. I don't know that it will go away. Once the pension funds get a taste of the product, the asset class, they get to understand it, they study it, they get some expertise in-house to work it, I think it's likely they'll stay permanently in that asset class. They may not grow it as aggressively as interest rates backup, but they'll -- my guess is they'll stay in the asset funds.

Raymond Barrette

Historically, we've not been that close to pension funds as our shareholders were not pension funds. So we've not been as close observers of that. But we understand and once an asset class becomes an accepted asset class, it tends to stick that way. Yes, John?

Unknown Shareholder

Another one for Allan, different subject. With Sirius, and you have a big European business, can you just talk about the floods in Europe. Traditionally in the U.S., flood is not insured, but can you talk about the situation in Europe and is this an insurance event and a Sirius event? Or is it more like the U.S. where it's not insured?

Allan L. Waters

Sure. Yes, it's an insurance event. Yes, it's a Sirius event. It's very early days. Floods are still ongoing. What we see so far is it might be comparable to some floods that occurred in 2002, roughly comparable, in scale to us, and so we're going to have some [indiscernible] loss. We're going to have some modest loss on Oklahoma storms, Oklahoma tornadoes. But so far, in the quarter, I would say we still have a pretty good looking quarter. So it's an event that's not a major event for us.

Unknown Shareholder

If I could follow up, given the tax advantages of the Bermuda reinsurers and the tax advantages of the pension funds, can we expect to see the domestically domiciled reinsurers be the most threatened by the entry of outside capital?

Raymond Barrette

Well, there's not a lot of them left. There's, obviously, we and there's Berkshire, and Berkshire's is pretty good at managing taxes. There's not a whole lot left, TransAtlantic, Allegheny. So I would say that's not likely to be a big change.

Unknown Shareholder

What about opportunities in runoff businesses out there, are you getting much increased competition for that?

Raymond Barrette

I'll let Allan.

Allan L. Waters

Yes, I mean there has been great increase in competition over the last 8 to 10 years for larger transactions. And there was the formation of Enstar, and then everyone sees the success of Enstar, a lot of Enstar look-a-likes formed. So large transactions had their returns bid down, and some competitors have done some things that weren't wise and are now troubled because of it. We did some larger transactions early on. That team had solutions and some larger transactions early on last decade. Since then, they've been focusing on small to midsize transactions where there's a lot less competition. It's a small team we have in Connecticut, so it doesn't take a large transaction to move the needle in terms of their profitability and so their ability to focus on smaller transactions, and they still are generating very high returns on those deals, is the difference. It's not -- we couldn't do that at scale. And then as far as scale, we wouldn't have the same returns in that business. But by focusing on smaller transactions, we're fine where we are.

Raymond Barrette

I think the team cost about $2 million a year.

Allan L. Waters

$2 million of operating cost a year.

Raymond Barrette

So they do a $5 million gain and they pay for $2 million, $3 million of those [indiscernible]. We're very happy with working the [indiscernible] and finding [indiscernible] $10 million, $20 million, and it adds up to $150 million over 10 years.

Unknown Shareholder

You're not getting. . .

Raymond Barrette

Try again.

Unknown Shareholder

You're not getting outbid in that area?

Raymond Barrette

Well, we get outbid all the time. All time, except on those where we win.

Unknown Shareholder

In the level of your focus you're not getting outbid that much.

Raymond Barrette

Sorry?

Unknown Shareholder

In the level you're focused on, you're not getting outbid that much.

Raymond Barrette

Yes, we get outbid all the time. I mean we're -- and quite often, if there's a highly successful auction, we're not going to win. Most recent transaction we did, I think, we looked at in -- went into runoff in 2000. We looked at in 2002, still green, with a bunch of others. We looked at it in 2004, it was still green with several others. And then it came around again last year and we were the only one left when we did the transaction. And that's happened several times, where there's been an auction, the seller didn't get their price, seller goes away for a while, they come back, and we're the last man standing. That's usually when we finally get something done. But, yes, there's competition even at the scale that we're operating at. I didn't mean to mislead you there, but the team's disciplined and there's plenty to be done at a very high return at that size.

Allan L. Waters

And some of the deals don't attract a lot of attention. People want big deals. They don't want $20 million deals. And the team has a relationship with the rehabilitators. They bid on 3 other things and so they have a good reputation that when they bid something, they actually close at that price. They don't change their minds at the last minute. They do their homework upfront. So they have a good reputation. Some people will give them exclusive. They'll say, at this price, if you can bid at this price.

David T. Foy

We've had complications where the regulator gave us some exclusive. Regulator said, yes, you can go ahead and do an exit as long as you do it with Solutions, White Mountains Solutions. So it's a team that's been in place a long time and knows everybody in the business, including the regulators.

Unknown Shareholder

Two easy ones. On the Brazilian thing, you're talking about the debt, is that a go, whatever it is?

Raymond Barrette

I'll let Manning talk about it.

G. Manning Rountree

That deal is fine, 2 weeks ago. It will close in another 2 or 3 weeks. It's a small deal. We're investing $3 million in the company for a 30% interest. It's a Brazilian "aggregator." In Brazil, you must buy your auto insurance through a broker, but the brokerage market is highly fragmented and opaque. And this company will -- but on the other hand, Brazil is very tech savvy and highly online as a country. And so we think the opportunity that this company is pursuing is a good one, which is to provide an online resource for consumers to compare some shop for auto insurance close initially and then expand into other product lines at that time, similar to the entry financial business that we owned when we Esurance.

Raymond Barrette

Yes, you could see why you're bothering to invest a few million dollars in Brazil, in a country you don't know and all that. But the 2 guys who run this business, they were not from Brazil. They looked at all over the world and saying, where should we build the business, and they picked Brazil. They moved to Brazil. They're building this thing in their garage. They are extremely successful in their early model and now, they need capital and these guys are winners. And so we invest only a few million dollars but I'd be disappointed if 5 years from now, it's not a much bigger, better opportunity. So that's why we kind of seed money here.

Unknown Shareholder

What does HG stand for?

Raymond Barrette

HG, Hudson Greenwich. But we live in Hudson Street in Greenwich, one of those things.

Unknown Shareholder

I was hoping for high growth.

Raymond Barrette

High growth. Hopefully for a while. It was a partnership. I mean these guys build this in their garage, too. And now they've moved to fancy offices with a big team of well-paid people and...

Unknown Shareholder

I'm just curious why you own 75% of OneBeacon. The Berkshire model is to own 80.1. Is there a tax advantage or what's the...

Raymond Barrette

The second part of the question is easy to answer. We don't consolidate. We could not consolidate the U.S. businesses. They're all owned from Bermuda. So there's no tax control issue there. The reason we own 75% is because at some point, we sold 30% or 28%. And since then, the company's bought back some shares. It was a great opportunity in '06 to do it. We did it. It worked out well. And once you have public partners, you have public partners. And you have to treat them well, and we're building the best business we know how and we hope the public shareholders do wonderful and we certainly will plan to share our 75% of that. Any more comments might be -- we wish we were much smaller.

Unknown Shareholder

Can you talk about the underperformance of the equity portion of your investments? I guess just from the last year or 2. I know 10 years has been pretty good compared to the S&P, but if maybe you can elaborate on why you underperformed the S&P in good times.

Raymond Barrette

Okay. I'll let Manning take that one.

G. Manning Rountree

I think if you look at the long-term track record, very good, absolute and relative. The near-term track record has not been good relative to the S&P and there are really 3 reasons for it. The first is in '08 and '09, we had to sell equity for capital preservation purposes and so we sold at the bottom. We've been able to hold those equities through the recovery or even take advantage by buying more, the numbers would look a lot better, but we couldn't do that for reasons not related to investment decisions, they were related capital decisions. The second reason is structural, and I talked about that in the slides. The composition of the portfolio has not just common stock, which we hope will meet or beat the S&P, but also things that have a little less data content and are defensive in nature, convertible bonds, high-yield alternative investments, which includes a heavy dose of long, short hedge funds, those types of instruments. So we're trying to mute downside and upside a little bit inside the equity. The third reason that we've underperformed in the last few years has been underperformance at our largest equity manager, which is Prospector. The 18 months ended June of last year was a tough patch for them. We think it's getting back on track. At the same time, we have taken some steps around the margins to diversify our equity holdings away from Prospector. They still manage a large chunk of what we do, but we've added some complementary managers in differing styles, styles that we think what we like to do but are different and diversifying from Prospector. So really, that's the story of the equity portfolio.

Raymond Barrette

John, do you want to add anything?

John Davies Gillespie

Yes, with respect to Prospector, [indiscernible] 2 things from the past 2 years and one was an error of omission and the other was an error of commission. The error of omission is one that we will likely continue to make in future periods, which is we're just not risk-on investors and when areas of the market like consumer discretionary are leading the market, we're going to lag. That's just been true our whole career and it's certainly been true the last 2 years as those sort of risk-on areas have led the market. The second was an error of commission, which is we made an ill-timed significant debt in the gold stock, which is just was wrong. Hasn't worked out. Now, that error has corrected itself by price in terms of that piece of the portfolio is now smaller than it was, but that's really those 2 areas and that has led to a short-term underperformance. Other contributing factors is that we have historically relied a lot on M&A as a catalyst to realize value on our portfolios and M&A has been not strong in the past 3 years, although it started to show its head a little bit in our portfolio over the last 6 months. So we would expect as M&A returns to more normalized levels, in terms of percent of market capital portfolio that, that will trigger some positive events in the portfolio. And I think I would just echo what Manning had said, which is we had a fabulous run at Prospector that lasted about 10 years, and so we started to diversify away from ourselves. Nobody gets it right forever consistently and so we started to add complimentary managers. They're all around at the value school but they approach things differently, growth at reasonable price orientation, more free cash flow yield orientation, we've built sort of this complementary block and so we feel pretty good about the portfolio today and I guess, David, [indiscernible]

Raymond Barrette

Anybody else? Everybody's ready for lunch? Thank you. We'll see you next year.

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